Foster’s and its wine offshoot face challenges

Any drinker knows that mixing beer and wine is never a good idea, but shareholders in our largest brewing company have found out the hard way.

This week
Foster
’s Group successfully spun off its wine business into the newly listed
Treasury Wine Estates
. The de-merger ended a 15-year, mostly fruitless foray into winemaking for Foster’s. It was an adventure plagued by a global glut in grape supply and management’s misunderstanding of the industry.

Critics says Foster’s previous management overpaid for its wine investments – made at a time when the global economy was in rude health and grape supply was much tighter than it is today.

It might have seemed like a good idea at the time but the combination of wine and beer left the company with a big headache and its multi-beverage sales strategy failed to ignite.

Since the purchase of Southcorp in June 2005, when the wine experiment was at its apex, Foster’s share price has flat-lined while the broader market has gained about 10 per cent.

“They might both be liquid, but the are two very different products," Perpetual Investments portfolio manager Matt Williams said.

It wasn’t a difficult decision for the board to spin off the wine business, allowing the two entities to focus on their different strategic priorities and manage their capital accordingly.

Nor was it hard to swallow for shareholders, who gave the plan a ringing endorsement. On Monday they received one share in Treasury Wine Estates for every three held in Foster’s. Since their debut, TWE is up about 2 per cent at $3.43. Shares of (the new) Foster’s closed on Friday at $4.32. The last traded price for the combined group was $5.48.

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The sharemarket now has a pure beer play, Foster’s, and a specialised wine play, TWE, offering investors a chance to make the same choice made by drinkers every day in pubs and restaurants around the country. Given the different characteristics of the two industries, it’s potentially a difficult one.

TWE is now the largest stand-alone wine company in the world. It’s the largest player in the domestic wine market, with 22 per cent market share, and has a significant presence in markets throughout Europe, Asia and North America.

As the third-largest supplier of wine in the US, it also offers exposure to a recovery in the world’s largest economy. But it faces some serious challenges at the moment from ongoing strength in the Australian dollar.

“The Australian wine industry had its glory days when the currency was at $US60¢. At $US1.10 it makes wines from Chile, South Africa and Argentina much more competitive," Mr Williams said.

The company has a portfolio of more than 50 wine brands, including Lindemans, Wolf Blass, Rosemount and arguably the most highly regarded brand in the country, Penfold’s.

But it faces a major task in selling its premium brands like Penfold’s overseas, where Australian wine has gained a reputation for being good and reliable, but also very cheap.

Foster’s also faces challenges. For the first time in a long time domestic beer consumption is under pressure. According to researcher Nielsen, in March volume fell 6 per cent compared to last year.

But one factor for investors to consider is that, over the longer term, share prices of the “child" entity usually outperform the parent in demergers, Macquarie Research says, with a median excess return of 10 per cent.

Foster’s also faces an issue with its supermarket customers
Woolworths
and the
Wesfarmers
-owned Coles, who are engaged in serious price competition with each other and looking to muscle in on the comparatively wide profit margins brewing companies enjoy. Earlier this year, Foster’s was forced to withhold supply from the supermarket giants to protect the integrity of its brands after it caught Coles and Woolworths selling Victoria Bitter and Carlton Draught at below cost.

But it’s not all doom and gloom. One potential catalyst for share price gains is corporate activity, which market watchers see as much more likely now the business have been split into two separate entities.

Citigroup analyst Andy Bowley told clients this week that, for the big players, a “pure beer play" was more attractive than a beer and wine group.

The market has already been rife with rumours that Asian brewers could be interested in Foster’s.

The UK’s SABMiller is also understood to be interested in the company, although not with the share price or the Australian dollar at current levels.

Meanwhile, TWE has already been subject to takeover interest, with US-based private equity group Cerberus making an unsuccessful move for the company last year.

Mr Williams says both Foster’s and TWE face difficulties but have the necessary characteristics – strong balance sheets and good management – to withstand the short-term pain and deliver over the long term.

So far, the market agrees, with the combined value of the two stocks at a slight premium to Foster’s share price before the demerger.

So maybe beer and wine can co-exist in a portfolio after all; it’s just a matter of keeping the two at arm’s length.